Deferred Acquisition Costs (DAC)

What Are Deferred Acquisition Costs (DAC)?

Deferred acquisition costs (DAC) is an accounting method that is applicable in the insurance industry. Utilizing the DAC method permits a company to concede the sales costs that are associated with getting another customer over the term of the insurance contract.

Understanding Deferred Acquisition Costs (DAC)

Insurance companies face large upfront costs while giving new business, including reference commissions to outside merchants and dealers, underwriting, and medical expenses. Frequently these costs can surpass the premiums paid in the early years of various types of insurance plans.

The implementation of DAC empowers insurance companies to spread out these large costs (that generally would be paid upfront) progressively — as they earn incomes. Utilizing this accounting method will in general create a smoother pattern of earnings.

Starting around 2012, insurers are required to follow another Federal Accounting Standards Board (FASB) rule, "Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts," or ASU 2010-26.

FASB permits insurance companies to capitalize on the costs of gaining new customers by amortizing them over the long run. With this cycle, DACs are recorded as assets — instead of expenses — and they can be paid off step by step.

Deferred acquisition costs (DAC) are treated as an asset on the balance sheet and amortized over the life of the insurance contract.

The FASB likewise expects that companies amortize balances on a steady level basis over the expected term of contracts. On account of unexpected contract terminations, FASB rules that DAC must be written off, however it isn't subject to a impairment test. This means that the asset isn't estimated to check whether it is as yet worth the amount stated on the balance sheet.

Special Considerations

Deferred Acquisition Costs (DAC) Amortization

DAC addresses the "un-recuperated investment" in the policies issued and is consequently capitalized as a intangible asset to match costs with related incomes. Over the long run, the acquisition costs are recognized as an expense that reduces the DAC asset. The most common way of perceiving the costs in the income statement is known as amortization and alludes to the DAC asset being amortized, or reduced over a number of years.

Amortization requires a basis that determines the amount DAC ought to be transformed into an expense for each accounting period. The amortization basis shifts by the Federal Accounting Standards (FAS) classification:

• FAS 60/97LP - Premiums
• FAS 97 - Estimated Gross Profits (EGP)
• FAS 120 - Estimated Gross Margins (EGM)

Under FAS 60, presumptions are "secured" at policy issue and can't be changed. In any case, under FAS 97 and 120, suppositions depend on gauges that can be rearranged depending on the situation. DAC amortization utilizes estimated gross margins as a basis and a financing cost is applied to the DAC in view of investment returns.

Requirements for Deferred Acquisition Costs (DAC)

Prior to the presentation of ASU 2010-26, DAC was depicted enigmatically as costs that "change with — and are fundamentally connected with — the acquisition of insurance contracts." That drove companies with the troublesome task of deciphering which expenses qualified for deferral and frequently incited a broad scope of insurance firms to order the majority of their costs as DAC.

FASB later inferred that DAC accounting was being mishandled. The board answered by giving clearer rules. ASU 2010-26 was joined by two important changes to meet the capitalization criteria:

• Companies may just concede costs associated with the fruitful placement of new business, as opposed to all sales-related expenses.
• Just a portion of administrative center expenses straightforwardly linked to incomes can be viewed as a DAC asset.

Instances of deferrable costs include:

• Commissions in excess of ultimate commissions
• Underwriting costs
• Policy issuance costs

Features

• Companies may just concede costs associated with the effective placement of new business and can't amortize all administrative center expenses.
• Utilizing this accounting method will in general reduce the first-year kind of policy and produces a smoother pattern of earnings.
• Deferred acquisition costs (DAC) is an accounting method that is applicable in the insurance industry.
• Utilizing the DAC method permits a company to concede the sales costs that are associated with procuring another customer over the term of the insurance contract.